Disability Income, is it taxable?

It really depends on where you receive your disability compensation from.

Disability benefits you receive from the Department of Veterans Affairs (VA) aren't taxable and don't need to be reported on your return. However, Military Disability Retirement pay could be taxable if reported on form 1099-R.

Workers' compensation benefits are not normally considered taxable income on your federal or state return. There is an exception when you receive both workers’ compensation and Social Security (or Railroad Retirement) benefits and part of your workers' compensation reduces your Social Security, that part may be taxable.

Disability benefits for loss of income or earning capability resulting from injuries under a no-fault auto insurance policy aren't taxable either.

Disability paid by an insurance company for lost wages, loss of limb, loss of sight (etc.) may or may not be taxable, depending on circumstance:

• If the premiums were paid by your employer and were not included in your taxable income, the disability is taxable.
• If you paid the premiums out of your own pocket or with payroll deductions that came out of your after-tax income, the disability is not taxable.
• If you and your employer jointly paid the premiums, only the disability amount covered by your employer's payments are taxable.

My wife receives  a disability check from the State of Illinois. Just recently we receive a letter stating that we owe them $164.00. When we called them back they stated that her disability payments were not taxable and should have never been filed and that we should submit an Amendment.  Is this true? And if so, Why wasn't this detected by TURBOTAX?

where do I show on the tax form my husbands VA disability income

Nowhere.  VA disability payments are not taxable or reportable on your tax returns.